Record low interest rates and the policy of quantitative easing helped boost the performance of all risk assets, particularly at a time of generally benign economic growth.
The programme of QE made bond prices more expensive, and minimised the returns available from cash deposits, encouraging investors into riskier assets such as equities and property, with lower than usual volatility.
So, an investment in a broad equity market tracker would have attained substantially positive returns for a decade, denting the appeal of actively managed funds, which would be expected to perform best at times of greater volatility.
The pandemic brought new waves of QE around the world, and further interest rate cuts, leading to a rapid recovery in asset prices in 2020.
But with the path out of the pandemic uncertain across different regions of the globe, and its impact hitting each sector of the market differently, the conditions in which active management does best may be starting to assert themselves.
John Husselbee, head of the multi-asset investment team at Liontrust, says investors should never view it as an either/or choice in any market conditions.
The fund manager says that while market conditions will always exist that cause certain active investors to underperform, portfolios designed with the long term in mind should combine both.
He says: “We have long held the view that active versus passive is a needless debate for fund investors, and they should choose both. Of course, investors in active funds should note that they will need to have the patience to withstand potentially lengthy periods of underperformance on the way to long-term wealth generation. This is what we refer to as noise-cancelling investment, which is central to our patient multi-asset approach."
A recent study from Vanguard looked at a data set of more than 2,500 actively managed US-domiciled funds over 25 years to the end of 2019. The research found almost all the outperformers experienced sharp falls versus their benchmarks and peers over several one, three and five-year periods.
Meanwhile, 80 per cent of the outperforming funds also had at least one five-year bottom-quartile spell and top managers can expect a continuous fall in fund values lasting at least two years every decade and a worse fall of at least 20 per cent. A separate study from Morningstar showed that even a very skilled manager, over a span of 100 years, would underperform their benchmark for a two-decade period during that time.”
Tom Sparke, investment manager at GDIM, says: "We use passives in a couple of different ways in portfolios. Where we are looking to gain exposure to a specific asset we may use a tracker fund where an active fund does not provide a higher degree of value. For instance, in the bond space we have not seen much value in allocating to actively managed gilt funds and prefer to pay a low fee for general tracking of the market.
"We do this with US treasuries, European bonds and Chinese bonds too. In the equity space we will often use a tracker when we wish to gain generic exposure, or as a cost-effective way to top-up a position in a certain theme or region."
Fahad Hassan, chief investment officer at Albemarle Street Partners, says the rise of passive investment products has been “a force for good” for clients, with the active fund management industry “not living up to the hype”, and businesses only cutting fees when under regulatory pressure.
Despite that, he sees a place for active funds in many portfolios. Hassan says the relative attractiveness of active versus passive solutions varies depending on the asset class.
He says: “The cost versus performance debate in the last decade has clearly favoured passives, but we do feel client interests are best served by spending our client fees in the handful of sectors where active payback is highest. These areas include UK equities, smaller companies, high yield and corporate debt and global emerging markets.
"On a style basis, fund managers with a growth bias have shown multi-year outperformance. While outperformance versus a well-diversified index such as the S&P 500 can be difficult to achieve, active managers competing against poorly constructed passive alternatives may have the upper hand.
"An obvious example of this is the corporate bond space, where a handful of lower quality issuers can dominate an index. A passive product is only as good as its underlying index and not all indices are constructed with risk-adjusted returns in mind.”
David Merton, a director in the alternative solutions team at Fulcrum Asset Management, says: “We believe there are many examples of an active solution being superior to a passive one. At the outset, it is important to look at what you are trying to achieve when selecting between the two.
"At some point along the investment value chain there are going to be active decisions; be those implementing exclusions, proxy voting, or producing an index inclusion formula. The point at which an investor engages with each part of this value chain will depend on their governance level, beliefs and objectives.
"Investors often choose passive solutions to minimise cost, regret risk [the risk of an investment doing worse than peers or the market], or just to keep things simple. For those less versed in investments or with a low level of governance, a simple passive solution is likely to be fit for purpose, but for larger investors, going passive without effectively considering other options is sub-optimal."
Merton adds: "We use our 'impartial implementation' approach to evaluate all investment routes. Impartial implementation means for each asset class or exposure we want in a portfolio, we assess whether the best way to access this is actively/passively, directly owning the securities or through synthetic, liquid or illiquid markets, etc.
"Evaluating each allocation in the round like this allows us to generate portfolio efficiency and achieve great value for money.”
Sustainable investing
The next turn of the wheel in the active/passive debate is likely to centre on ESG investing. As assets pour into the sector, active management companies are increasingly launching products to meet this demand.
Central to their thesis is that one cannot invest both sustainably and passively, as the work to understand the true characteristics of a company requires active fund management.
Ken McAtamney, head of the global equity team and a portfolio manager at William Blair Investment Management, says: “Active management allows investors to enter into a dialogue with companies on key ESG issues and a voice that can be used for positive change.
"Passive approaches typically rely on third-party ratings to screen companies, while active approaches have a more expansive toolkit to derive value from ESG analysis. This includes engaging with companies on material issues – for example, workers’ rights.
"Passive ESG strategies tend to be more backward-looking given the nature of third-party ratings, which are only refreshed on an annual basis and can overlook important inflection points.”
He notes that active managers "aren't captive shareholders" and that their ESG-related concerns may "warrant divestment from certain companies with significant controversies, or where engagements are unsuccessful, whereas passive funds do not have this advantage".
He adds: "Ultimately, active management involves dialogue with companies, which provides more nuanced insight into business practices and strategies than screens and computers can.”
GDIM's Sparke says he has yet to come across a passive ESG fund product that works for his clients.
David Thorpe is special projects editor at FTAdviser
